Expect to make mistakes when managing your own business, especially with the books. However, many financial gaffes can be prevented by learning to bypass these accounting pitfalls:
- Combining personal and business finances – Making something more difficult than it already is, is never an efficient strategy. Mixing your personal and business finances is guaranteed to create an ugly mess. It’s critical that personal and business finances are kept separate at all times. All new business owners should open up a business checking account and deposit all business income into this account. This will make it easier to sort out when it’s time to fill out your taxes.
- Misclassifying workers – The IRS has several different employee categories. Your employees can either be full-time, part-time, temporary employees or even independent contractors. Whether it is done by mistake or on purpose, misclassifying your workers in the wrong categories can be costly, leading to IRS audits and fines.
- Profits vs. cash flow – Cash flow and profit are not the same thing. Confusing this fact is a common mistake that could kill your business. Cash flow is the amount of money moving in or out of your bank account. Profit is taking your total expense minus your total income. Due to the lag between invoices and bills, profit and cash flow will usually differ. For example, in June you make 50 widgets at a cost of $50. You sell each widget for $200, but the customer chooses not to pay you until July. June is now a profitable month because your costs were less than your projected income. However, your cash flow for June is negative because you have not received payment from the customer. Please be sure to separate profits and cash flow. Treating them as distinctly different monies can save your books from disaster.
- Not retaining purchase receipts – The IRS does not require a receipt for business purchases under $75. The IRS requires that all business expenses be reported such as travel, meals and entertainment if they are greater than or equal to $75. Working out your business costs accurately over the year becomes more and more time-consuming. You may risk failing to account for certain expenses, which means paying more tax than you need to. The IRS may not need receipts under $75, but these can be extremely helpful as a reference when you need to work on your annual tax return.
- Paperless work environment – Electronic bookkeeping systems are generally more convenient than filling out paperwork. However, we highly recommend that you don’t neglect paperwork. There are many instances in which paper documentation of financial records will come in handy or be required. The IRS may sometimes require physical financial records. If you choose to eliminate paperwork and go strictly digital, then what happens if your data is damaged, stolen or destroyed? Carefully consider your situation. Keep cloud backups of all critical data and consider keeping paper records of all major finances.
- Regular account reconciliation – Ensuring that the money leaving your business account matches the actual money spent is essential for your business. With cyber-crime rising at an alarming rate, this reconciliation will alert you of any unauthorized charges. Doing this on a monthly basis helps ensure that accounting errors are caught and corrected quickly before they result in a major financial problem.
Prepare your business and build it on a strong financial foundation. Be sure you understand how to read your financial reporting. Remember that poor financial management is the chief cause of small business failure. Avoid making these simple financial mistakes and it will make the ride all that much smoother!